After the recent removal of the Swiss franc cap by the Swiss National Bank, a cap that had previously been keeping the currency in check, markets responded with great volatility with many traders and brokers making significant losses. In response to this, we sat down with our CEO, Ajay Pabari, and asked him how Spread Co avoided losses through effective risk management.
What is the background to the huge losses incurred speculating on the Swiss Franc?
Historically, Switzerland has had one of the strongest currencies in the world. The country has always been neutral, experienced very little political or economic turmoil and is very good at managing its economy. Whenever there is economic uncertainty or volatility in global financial markets, everyone buys gold and the Swiss franc.
This happened in the wake of the Eurozone debt crisis in 2011 and the strength of the Swiss franc made life difficult for the country’s exporters. In September 2011, the Swiss National Bank capped the currency to the euro at 1.2000.
Whenever there was pressure on the currency, the Swiss National Bank would buy up euros so the Swiss franc wouldn’t go below the cap.
Last week the Swiss National Bank decided to abandon this peg and the result was a 20-30% hike in the value of the Swiss franc.
Why was this significant for firms and traders betting in the foreign exchange markets?
Before last week, if anyone wanted a safe trade, all they had to do was speculate that the euro wouldn’t fall below Sfr1.20. By and large, if a trader held a long position in EURCHF then they would make a small return on the interest rate differential and also on the exchange rate movement. It was a trade for the most risk-averse clients, the safest trade in the world, or so people thought.
How did Spread Co avoid multi-million-pound losses suffered by many spread betting firms?
I’ve been around for so long; I remember when Norman Lamont pulled the pound out of the European Exchange Rate Mechanism on Black Wednesday in 1992.
The nation just couldn’t afford it anymore and it was inevitable that the Swiss National Bank would come to the same conclusion sooner or later. Unusually, we placed a higher margin requirement on that trade, which discouraged many clients. It meant we didn’t have that much exposure and were able to trade normally and profitably.
Were you affected at all?
There wasn’t the mayhem seen elsewhere but we did still have to act quickly. We were able to close down the positions of those traders who were exposed to try to prevent their accounts running into serious deficit. We maintained our liquidity even when it was pulled by the interbank markets and we were in a position to make a two-way price to our customers, fulfilling our best execution obligation. As a consequence one of our clients made over $100,000 by opening a trade near the intra-day low point.
Why were other spread betting firms hit so hard?
Most brokers require 1% or less as margin from clients for currency trading. That means clients only have to put up £10k for a £1m trade. If one currency falls sharply against another with margins at 1% or 2% then losses can rack up quickly, especially if the price moves in excess of 25%, as in this instance, which is astonishingly rare.
Normally when a market moves against a client, a firm will close the position quickly to limit losses but many firms were unable to do this because of the lack of liquidity in the interbank markets and the speed at which the market moved.
The fall in the euro against the Swiss franc was between 20% and 30% during the day so significant deficits were racked up. For example, a 25% fall on a one per cent margin on a million-euro trade means a loss of €250,000.
Financial spread betting firms are all regulated by the Financial Conduct Authority, and we all have to adhere to their rules regarding holding client money in segregated accounts.
If there’s a deficit on a client’s account, a firm has to make up these funds from their own cash resources, the impact comes when they can’t make up for those client funds. Even if clients are liable for the losses, the spread betting firm has to be able make up the shortfall immediately.
If the client pays in a week’s time that’s no good: they need to make up the funds on the day, so need adequate surplus resources or go into insolvency.
So huge reserves are required for financial spread betting firms?
All regulated entities are required to have a minimum resources requirement, depending on a variety of factors, and do have to also take into consideration market volatility, such as what we saw on Thursday. It was just unprecedented and blows those resources requirement calculations out of the water. A 25% movement is astonishing.
Did anything like this happen on Black Wednesday, when Norman Lamont pulled the pound out of the European Exchange Rate Mechanism?
That was a different era; there were fewer currencies that were being traded and the leverage offered was not as aggressive as presently available. There were fewer clients and a limited amount of spread betting companies at the time, and in terms of leverage, 10% was the typical margin, not 1%. The environment was significantly different – everybody was more cautious, clients were not as aggressive, there was no the so-called safe trade like the Swiss franc. The level of speculation was lower and the pound was one of several currencies under pressure. Here it was all against the Swiss franc, as few caps existed anywhere else (Denmark has one). That made the risks much bigger.
Do you count yourselves lucky?
Our situation was down to strong risk management, controls and adequate capitalisation to be able to withstand this type of event.
What is the lesson to traders?
There are no safe bets out there. Many people have been hurt because they were so heavily exposed to the Swiss franc. Spread betting itself is not the issue, it’s about discipline. Building trading techniques and styles that incorporate some degree of risk management and not over-leveraging. We can’t impose those disciplines on people but we do encourage clients to understand their risks and to manage them.
Does that just mean putting a stop-loss in place?
Even if you have a stop-loss in place, if the price goes through the stop-loss, your order only gets executed at the first available price. In an illiquid market the final price could be a long way from the stop-loss trigger point.
What are the lessons for traders in terms of which company they should be using?
We compete successfully on price, but traders need to look further than just price. It’s worth reviewing the performance of different providers in the wake of this. Ask yourself:
How credible were they during this period?
What did they offer?
Could you get out of trades, or instigate trades at that time?
We made a two-way price in all the Swiss crosses that we offer our clients and it mirrored the liquidity in the market. We didn’t pull our prices, we didn’t stop quoting prices, we made sure our clients had the opportunity to trade these markets throughout the turmoil period even when liquidity was completely dried up we still made prices for our clients to trade and fulfilled our best execution obligation.
We limited our losses, we got out immediately. We didn’t have too many clients with exposure but those clients’ trades were quickly executed. We had one client who made money. When the euro plummeted to depths that were unseen before, they bought at those low levels and made a significant amount of money when it bounced back. We were happy to facilitate that trade. It made that client over $100,000.
As a firm we made money on that trading day.